Working Paper

Tax Policy Endogeneity: Evidence from R&D Tax Credits

Abstract: Because policymakers may consider the state of the economy when setting taxes, endogeneity bias can arise in regression models that estimate relationships between economic variables and taxes. This paper quantifies the policy endogeneity bias and estimates the impact of R&D tax incentives on R&D expenditures at the U.S. state level. Identifying tax variation comes from changes in federal corporate tax laws that heterogeneously impact state-level R&D tax incentives due to the simultaneity of state and federal corporate taxes. With this exogenous variation, my preferred estimates indicate a 1 percent increase in R&D tax incentives leads to a 2.8-3.8 percent increase in R&D. Alternatively, estimates that ignore endogenously determined policies indicate that a 1 percent increase in R&D tax incentives leads to a 0.4-0.7 percent increase in R&D. These results are consistent with tax policies that are implemented before an economic downturn.

Keywords: Corporate tax; fiscal policy; R&D price elasticity; tax credits; policy endogeneity;

JEL Classification: H20; H25; H32; H71; K34; O38;

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Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 2014-11-21

Number: 2014-101

Pages: 58 pages